How Much Growth Can Transurban Deliver?

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Toll road builder/operator Transurban has raised FY17 distribution guidance. While brokers acknowledge the strong growth on offer, questions linger regarding the extent of optimism in forecasts.

-Distribution growth strong but likely to be slowing from the 11% experienced since FY09
-Capital release considered a lower quality aspect to the half year result
-Potential sale of West Connex a key catalyst in 2017
 

By Eva Brocklehurst

The run of strong growth continues at toll road builder/operator Transurban ((TCL)), with the highlight from the first half result being an increase in FY17 distribution guidance to 51.5c from 50.5c. The company remains confident of reaching financial close on the Victorian Western Distributor in late 2017, but notes the timing for funding the transaction is subject to negotiation.

The company has also confirmed its interest in West Connex, with the NSW government currently considering a privatisation process. Transurban confirmed it has not participated in the US Dulles Greenway expressions of interest at this stage but is maintaining a watching brief.

Credit Suisse expects Transurban to deliver over 10% distribution growth in each of the next five years and believes the higher distribution guidance signals management is also confident. The broker downgrades its US express lane estimates, suspecting it had previously over-estimated the revenue growth from the 495 and 95 express lanes. The broker believes the stock is attractive on a forward distribution yield basis and retains a Outperform rating.

Morgans forecasts distribution growth of 8% per annum across FY18-20, implying a slowing of growth versus the 11% experienced since FY09. The broker downgrades to Hold from Add, given the share price strength, but believes investors will continue to be attracted to the company's defensive compound growth and solid investment grade credit rating.

The broker's forecasts conservatively include an $8m capital raising to support the funding of the proposed Western Distributor, despite the CEO warning that a capital raising may not be necessary.

CLSA suspects the market is being overly optimistic in its forecasts and believes proportionate operational earnings (EBITDA) growth will be less than 10% in FY18 and beyond. While management has been good at adding growth through new concessions, the broker worries that West Connex is a "must buy", abetting concerns regarding the price that might be paid. The broker, not one of the eight stockbrokers monitored daily on the FNArena database, has an Underperform rating and $11.10 target.

Traffic performance and margins at CityLink and Hills M2 particularly pleased Deutsche Bank, given there were traffic disruptions during the half. The broker notes no further capital returns or re-financing are expected in the second half, but the company has indicated a further re-financing could occur once North Connex is completed in FY20. The broker suspects further competition could enter the Australian market in any bidding for West Connex, given its size and scale, and these players may be prepared to bid very aggressively.

Strong Cash Flow But Quality Questionable

Free cash flow was boosted by around $170m in a one-off capital release. On an underlying basis, UBS notes cash flow was still up 10%, although accounting for a 6% rise in securities on issue, free cash flow per security was only up 3%. The broker attributes the difference to traffic disruptions and funding costs associated with CityLink and North Connex projects.

The strength of free cash flow impressed Morgans although the quality was questionable, the broker agrees, normalising for the capital release results in around 99% distribution coverage and only 3% growth in underlying cash flow. Around 8.5c per security is calculated to be related to the capital release as a result of the North Western Roads Group (NWRG) achieving North Connex construction milestones. The company has stated this cash goes back to the general funding pool to fund developments.

The broker acknowledges the company does not have access to the free cash flow from the 495 and 95 express lanes, as lenders restrict distribution of the cash flow during the interest capitalisation period. The trapped cash continues to accumulate and will ultimately be available to Transurban. Combining these items, Morgans calculates it reduces the free cash flow to 22.7c per security from 33.3c per security, providing around 91% coverage of the distribution. This is still within the targeted 90-110% pay-out range.

Macquarie also observed the capital release was a lower quality aspect to the result but, importantly, notes Transurban is not including this capital in developing its distribution guidance. Morgan Stanley also believes the company can maintain its free cash flow/distribution coverage ratio at around 100% in FY17, excluding the capital return from NWRG.

Significant Opportunity in West Connex

While debt increased, the company's net debt to EBITDA ratio continues to fall, which highlights for Macquarie the growing capacity in the balance sheet and underpins commentary that material equity may not be needed for current projects. The broker believes any capital raising is likely to be delayed until after the Western Distributor financial close, i.e. the first half of FY18.

This also coincides with a more significant opportunity, West Connex. If only stage one and two are tendered, the bidding will be similar to the QML and Airportlink, in the broker's view, in that it will centre on traffic forecasts. Macquarie believes Transurban would be at an advantage if all three stages and ancillary projects were on offer, as the company could leverage its design optimisation project delivery skills.

UBS also notes the potential sale of West Connex will play out this year and believe this is a critical issue for Transurban, both as a growth opportunity and to protect its Sydney incumbency. UBS considers the stock well supported versus other yield peers because of its strong growth, albeit with some event risk around the Western Distributor and West Connex outcomes.

Citi, too, believes concerns over higher yields are overdone, given average debt maturity of 9.3 years and the benefits to toll pricing from higher inflation. The broker continues to envisage upside for the stock as it delivers on existing growth options and manages existing operations for greater efficiency.

Demographic Trends

Morgan Stanley highlights the risk of a change in the take-up of ride-sharing services on the company's northern Virginian roads, where high-occupancy vehicles are exempt from tolls. The broker takes a look at demographic trends and notes, in Australia's case, the average age of motorists is steadily increasing in line with the general population. Of interest, while driver licence numbers in the 20-29 year-old bracket are growing, there are early signs that licences in the following cohort are falling, particularly in Victoria.

At this stage, the broker speculates that the younger cohort will make more use of taxis and ride-sharing as it enters the workforce and technologies continue to improve. In addition, the broker notes the Australian Taxation Office has issued an alert and flagged a review of certain stapled trust structures. The broker acknowledges, while the company's corporate structure includes multiple such entries, the ATO views the company as a low non-compliance risk. Still, the broker believes these are risks to monitor.

The database shows four Buy ratings and three Hold. The consensus target is $11.72, suggesting 7.7% upside to the last share price. Targets range from $10.05 (Deutsche Bank) to $12.40 (Macquarie, UBS). The distribution yield on FY17 and FY18 forecasts is 4.7% and 5.1% respectively.
 

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